Market View

Has the argument for long-term low inflation been blown away?

bank of england
Jonathan Marriott, Chief Investment Officer

In 2014, I suggested that long-term deflationary influences would keep inflation in check for a prolonged period of time. I questioned if inflation was a 20th century problem and suggested we could be in for a period more like the 19th century when prices on average fell 0.4% per annum*. From 2015 to 2021, UK CPI averaged just 1.6% year on year, despite historically low unemployment and interest rates for most of that time. However, as we move towards double digit inflation this year, it is time to take another look at this thesis. The latest Bank of England quarterly report sees inflation falling back towards the 2% target over the next two years and to be 1.3% the year after, so the idea may not be false.

My original article suggested that modern day technological innovation and globalisation are akin to the Industrial Revolution. In the 19th century, production shifted to centres of mass production within the UK. Meanwhile, in the 21st century, production shifted to the Far East and China in particular. The internet facilitated this, making it easy to communicate instructions globally in seconds. Internet price comparison sites made it harder to raise prices and to buy directly from the manufacturer removes a cost layer. In the UK, we created plenty of jobs, but immigration provided a cheap source of labour from the European Union and an ageing population added deflationary pressures.

Unforeseen events

When writing in 2014, I did not foresee a pandemic or a war in Ukraine which have both contributed to today’s inflation levels. For the UK, Brexit has also added to inflationary pressures. While the impact of the pandemic was initially deflationary due to the stimuli applied by governments and central banks, the increase of pent-up demand and ongoing supply issues have pushed inflation way above central banks’ 2% targets. Central banks are moving to raise rates and to reverse the quantitative easing that they applied during the pandemic. This, together with rising prices, constrains consumer spending but does little to improve the supply side of the equation. Energy and food prices have soared this year and, as the war in Ukraine continues, they are unlikely to reverse any time soon. That said, if annual inflation is to remain at this level, then the price rises need to repeat which seems unlikely. Inflation should trend lower once the recent costs have been priced in. We may already be past peak inflation in the US, but in the UK the energy price cap which will rise again in the autumn means the peak may be delayed until the final quarter. The danger is that, with low employment, wage demands will look to beat inflation. In countries where trade unions are powerful, this may be more of a problem. 

Economic outlook and prospects

The US may have seen inflation peak, but the Federal Reserve is set on a tightening cycle and appears determined to get inflation lower. This raises the risk of a recession, but the US economy is strong with low unemployment and less dependent on external demand than other countries. President Biden has limited room to manoeuvre on the fiscal side and the mid-term elections are unlikely to make it any easier for him. 

The UK government is, with a parliamentary majority, politically in a stronger position but has a more difficult balancing act to perform. This week, we have seen a package of measures to offset the energy price rise that is coming in the autumn, funded by a tax on oil and gas companies. This is welcome for households struggling to cope with rising fuel costs, but it may make the Bank of England’s job harder as it supports consumer demand. At the margin, this may mean UK rates have to rise sooner. There will be challenges from public sector workers looking for inflation-busting pay rises and pensions and other benefits linked to inflation set for a potential 10% increase this year. Overall, the UK peak in inflation may be later than the US and be slower to come down.

The war in Ukraine continues to have a dreadful toll on its people and, through food and energy supplies, a dire impact on the global economy. We discussed the impact of food supplies last week. However in the very long term, production will resume and Russian supplies of oil and gas will return to the market. The raw material price rises we have seen this year may not be repeated and some may eventually decrease. Global supply chains have been severely disrupted by the pandemic and this disruption continues with ongoing lockdowns in China. This has made many people question the globalisation of trade, but the pandemic will come to an end and manufacturers will continue to seek out cheaper manufacturing locations. If not, they may bring production closer to home which could mean a greater use of automation and artificial intelligence. Ageing populations are still an issue in many developed countries adding to deflationary pressures.


The arguments for low inflation remain long-term but have been blown away in the short term by events. Inflation is not going away this year, but I am inclined to agree with the Bank of England’s view that it may be constrained again in years to come. In 2014, I compared the 21st century with the 19th century and in the 19th century there were plenty of years where inflation exceeded 10% but, over the century, prices fell. We live in a different world today, but inflation is not inevitable. For now, interest rates are rising but, if a recession beckons and inflation moderates, the extent of rate rises may be limited. 

*source Bank of England and all other data Bloomberg

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